Merrill hit by unseen $500m charge

A boo-boo that should not have occurred, especially for a bank like Merrill.

In summary (as quoted in news article):
$500m in losses appear to have come from the discovery that Merrill used a flawed model for measuring the value of derivatives that were used in its hedging strategy. Auditor Deloitte & Touche concluded that Merrill had “not maintained effective internal control over financial reporting” as of the end of 2008.

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25 Feb 09 (FT)

Merrill hit by unseen $500m charge

Ineffective internal controls at Merrill Lynch caused the firm to understate its 2008 losses by more than $500m, the investment bank said on Tuesday in its annual report.

Merrill, which was acquired by Bank of America on January 1, shocked investors last month with the disclosure of a $15.3bn loss for the fourth quarter of 2008 and full-year losses of $27.1bn. But in its revised figures, Merrill disclosed that its losses for 2008 were $27.6bn.

The additional $500m in losses appear to have come from the discovery that Merrill used a flawed model for measuring the value of derivatives that were used in its hedging strategy.
Auditor Deloitte & Touche concluded that Merrill had “not maintained effective internal control over financial reporting” as of the end of 2008.

The disclosure is another blow to the reputation of John Thain, the Merrill chief executive who was ousted by BofA chief Ken Lewis last month. Mr Thain was hired by Merrill in late 2007 in part because of his reputation as a skilled risk manager.

Mr Thain spent several hours on Tuesday giving testimony to prosecutors in the office of New York Attorney-General Andrew Cuomo about the early payment of bonuses last year. Mr Lewis will also testify in the matter.

According to the annual report, the discrepancy in valuation involved internal swaps used between Merrill and its affiliates. In 2008, the report said, Merrill “began using a different set of yield curves to value certain intercompany swaps”.

In its opinion, Deloitte said “several mitigating internal controls were not operating effectively and therefore failed to identify the intercompany difference that resulted” from reliance on the two different yield curves. In addition, Deloitte said Merrill management did not apply proper accounting guidelines to one hedge entered into during the fourth quarter, involving long-term borrowings.